Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Real Estate Joint Ventures, October 2010
Pre-conditions to Pulling the Trigger
A basic question to be addressed when negotiating a real estate joint venture buy-sell shotgun is: Are there to be pre-conditions to pulling the trigger on the shotgun? Some joint venture agreements provide that the shotgun may only be invoked in certain specific circumstances, such as a deadlock or disagreement in respect of a major decision. The disadvantage of this approach is that it undercuts one of the principal rationales for the shotgun. The more pre-conditions which are imposed, the more likely a recipient of a shotgun notice will be successful in obtaining an injunction to restrain a buysell shotgun transaction. This could lead to lengthy court proceedings and concomitant delays.
Often, a joint venture agreement contains a prohibition on initiating a shotgun if a joint venture participant is in default of its obligations thereunder. It is reasonable to expect that a joint venture partner which is in default should not have the ability to invoke a shotgun unless it remedies its default.
One of the more common pre-conditions to the triggering of the shotgun contained in a joint venture agreement is a deadlock or disagreement in respect of a major decision. Certain joint venture agreements provide that the shotgun may only be invoked in such circumstances and for no other reason. Other joint venture agreements contain a provision requiring that a joint venture participant which intends to exercise the gunshot deliver to the other joint venture participant written notice of such intention prior to the actual exercise of the gunshot, thus affording the opportunity of a "cooling-off" period. This latter provision is sometimes euphemistically referred to in the U.K. as the "gin and tonic" clause and contemplates that the respective chief executives of the joint venture participants would meet over a gin and tonic to discuss matters after it became evident that there were serious difficulties arising from their joint venture arrangement. For the intended recipient of the notice, this provision affords an opportunity to arrange financing and obtain market intelligence so that it might be in a position, if it so determined, to exercise the right to buy arising from the shotgun.
Hoist or Prohibition on Triggering the Shotgun
A number of joint venture participants – especially those involved in development properties – do not want to have a buy-sell shotgun apply during the period of construction. Accordingly, many joint venture agreements provide for a "hoist" or a prohibition on the triggering of the shotgun from the time of commencement of construction until substantial completion of the project. There is obviously a legitimate business rationale for such provision, as the joint venture participants seek stability during such periods. However, such provision raises the issue of the manner in which a dispute between the joint venture participants arising during that period is to be resolved. The most practical way of addressing this issue would be to provide in the joint venture agreement for such disputes to be determined by arbitration or a panel of experts.
Occasionally, joint venture participants agree that there is to be a "one-way" restriction. Typically, this arises in situations in which one joint venture participant manages the project and makes all of the business decisions, while the other takes a passive or handsoff role. The passive joint venture participant may be reluctant to allow the joint venture participant which manages the project (or whose affiliate manages the project) and makes the business decisions to invoke the shotgun on short notice. In such circumstances, the passive joint venture participant may be concerned that the managing joint venture participant will use inside information to price the shotgun notice, thereby placing the passive joint venture participant at a significant disadvantage. Certain joint venture agreements address this situation by providing for detailed reporting requirements on the part of the managing joint venture participant or by including a restriction to the effect that the managing joint venture participant may not invoke the shotgun as long as it continues to manage the project.
The "one-way" restriction can sometimes apply to the passive joint venture participant. Typically, this arises in a situation in which there is a hoist on the shotgun and the passive joint venture participant initiates measures to terminate the affiliate of the managing joint venture participant as manager under the property management agreement. In such instance, the managing joint venture participant would be entitled to invoke a buy-sell shotgun so as to save its management role and force a resolution of the dispute one way or the other, and avoid losing control over the management of the project.
Other Timing Issues
The exercise of the buy-sell shotgun raises issues of timing which should be considered. The majority of joint venture participants take the view that a relatively short period to respond to a buy-sell shotgun notice is appropriate on the basis that the exercise of the shotgun is indicative of the existence of a serious dispute which needs to be resolved in an expeditious manner.
Market forces also favour a short response period as well. The longer the period of time to respond to a buy-sell shotgun notice, the greater the risk to the joint venture participant which initiated the process. The buysell shotgun notice states that the initiating joint venture participant will buy the interest of the other joint venture participant at a specified price irrevocable for a stated period of time. The initiating joint venture participant is taking a risk that there may be price fluctuations during the intervening response period due to material adverse or positive changes.
Institutional investors are often concerned about the timing of board of directors meetings, worrying that a shotgun notice will arrive and a response be required before they have an opportunity to submit the matter before their board.
As noted above, the more financially constrained joint venture participant often prefers a longer period of time to respond to the shotgun and to close the transaction.
One mitigating approach is to delay the closing somewhat after the decision to buy or sell has been made. This may help in certain circumstances. However, it should be borne in mind that, once a response to the shotgun has been delivered, it becomes a binding agreement of purchase and sale.
In addition, the structure of the project financing is extremely relevant to the question of timing. If the project is fully financed with fully assumable nonrecourse financing, many of the closing concerns evaporate. However, if the project is financed with a loan-to-value financing at 50%, the purchasing joint venture participant needs to find the funds to acquire the 50% equity interest of the other joint venture participant.
Failure to Close
All joint venture agreements which contain a buy-sell shotgun notice provision should also include a provision dealing with the failure on the part of a joint venture participant to close the purchase resulting from its exercise of the buy-sell shotgun. Such provision should stipulate that the other joint venture participant has the right to reverse the process and buy out the interest of the defaulting joint venture participant at a discount – say, 90% – of the previously agreed sale price. Such a provision serves as a safeguard against the possibility of a joint venture participant agreeing to purchase the interest of the other joint venture participant in the expectation that it may be able to arrange a new joint venture participant or financing before closing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.